Mad Money

Cramer: China's trade war on the US could be huge

Cramer: China's trade war on the US

Did the entire market come down with a case of amnesia, and forget all about when the miners, industrials and biotechs roared on Monday? Judging by the action on the averages on Tuesday, Jim Cramer suspects that could be the case.

"Last night I tried to be skeptical, if not downright critical, about the rally, suggesting it could easily be repealed as the week went on. I didn't know it would be repealed immediately," the "Mad Money" host said.

That's because Cramer was not expecting that investors would be dealing with a Chinese currency devaluation, which makes China's goods cheaper to export and U.S. goods more expensive to sell there.

The devaluation shocked Cramer so much that he decided to review what happened, so that investors can be prepared for what is next.

First, China is totally desperate. It is clear to Cramer that the Chinese Communist government is trying to put everyone to work while also trying to stop widespread corruption in business and politics. It tried to fix the issue by exports, but then Europe fell apart. Then it tried infrastructure, but now it seems as if everything it needed has been built.

An investor looking at stock prices in Haikou, China, August 11, 2015.

It even tried to boost its own stock market, but it didn't put enough rules in place to protect the gamblers who borrowed massive amounts of money and sent stocks flying before they crashed. Now, investors recently learned that Chinese exports have dropped 8 percent, an astounding number, and the Communist Party took a desperate measure and devalued its own currency by almost 2 percent.

"That might not seem like much for a country that's devalued before to stay competitive, but this move is five times bigger than anything the Chinese have done in the last decade," Cramer said.

The market recognized what these signals meant—a trade war.

That is precisely why so many stocks, including Apple and General Motors, were so weak on Tuesday; China clearly wanted its consumers to buy goods of Chinese companies.

Cramer interprets the devaluation as a sign that things are much worse in China than even the bears realize. After all, why else would it take such extreme measures?

"That means we have more risk to the entire world's growth than we thought," Cramer said. (Tweet This)

As a result, there are two important things that Cramer wants investors to keep in mind. First, none of the companies with sinking stocks on Tuesday have been a part of the bull market recently. That means it is time to rotate back to dividend stocks that yield 3 to 5 percent, like General Mills and PepsiCo. Domestic stocks with no Chinese exposure can go higher.

But the more worrisome side to China's desperate move is that it is reminiscent of the same moves seen by Japan and Europe when they both tried to stimulate exports to get the economy going. In other words, they were trying to take sales away from American companies. They want to depress U.S. exports and boost U.S. imports.

It's working, and that is precisely why Cramer is worried.

"Our recovery seems real, but it's shallow. Other than employment, there's nothing really strong about recovery at all," Cramer added.

Read more from Mad Money with Jim Cramer

In his perspective, it is entirely possible that a Fed tightening in September could cause serious repercussions for all U.S.-based international companies. In fact, it would not shock Cramer to see the U.S. go back into a recession if the Fed isn't mindful of the trade war declared on the United States.

Thus, if the Fed does not take what is happening in China seriously, a rate hike could cause real damage. It's time for the Fed to be data dependent, and realize that the rest of the world is uniformly awful.

"If we're not careful, we could reprise the 1937 recession within a Great Depression scenario caused by a Fed that also felt it just had to raise the rates, because, well, the worst was over. It wasn't," Cramer said.

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